Delaware Supreme Court Reinforces Directors’ Oversight Obligations on Mission-Critical Subjects

The Delaware Supreme Court recently reversed the Chancery Court's dismissal of a breach of the duty of loyalty claim against the directors of Blue Bell, a monoline ice-cream company. The court held that "[w]hen a plaintiff can plead an inference that a board has undertaken no efforts to make sure it is informed of a compliance issue intrinsically critical to the company's business operation, then that supports an inference that the board has not made the good faith effort that Caremark requires." Marchand v. Barnhill, 2019 WL 2509617, at *13 (Del. June 18, 2019).

Summary

The case arose from a listeria outbreak in Blue Bell's manufacturing plants. Three people died, and Blue Bell recalled all of its products, shut down production at its plants, and laid off one-third of its workers. The company faced a damaging liquidity crisis that necessitated a private equity investment that was dilutive to shareholders. A shareholder filed a derivative action, asserting claims for breach of fiduciary duty, including a so-called "Caremark" claim against Blue Bell's directors. Under Caremark, a board's "utter failure to attempt to assure a reasonable information and reporting system exists" is an act of bad faith in breach of the duty of loyalty. In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 971 (Del. Ch. 1996).

The Chancery Court dismissed all claims. As to the Caremark claim, the Chancery Court concluded the plaintiff was challenging the effectiveness of monitoring and reporting controls in certain instances—not their existence. That, the court concluded, was not a valid Caremark theory. On appeal, the Delaware Supreme Court reversed.

The court ruled that the plaintiff alleged particularized facts supporting a reasonable inference that the Blue Bell board "made no effort" to implement a board-level system to monitor the safety of the company's only product. Critically, the court reached that conclusion based on an unusual set of egregious facts. Based on a pre-lawsuit review of Blue Bell's books and records, the plaintiff alleged that the board "had no committee overseeing food safety, no full board-level process to address food safety issues, and no protocol by which the board was expected to be advised of food safety reports and developments." The plaintiff also alleged that management was aware of significant food safety issues but failed to report those issues to the board, further suggesting the absence of a food safety reporting system.

Defendants argued that board-level monitoring of food safety was not required because the company was subject to extensive federal and state regulatory requirements, including regular government inspections of Blue Bell facilities. The court rejected those arguments, noting that nominal compliance with regulations "does not imply that the board implemented a system to monitor food safety at the board level."

The court concluded that plaintiff's Caremark claim could go forward because the particularized facts in the complaint "support[ed] a reasonable inference that the Blue Bell board failed to implement any system to monitor Blue Bell's food safety performance or compliance."

Effect of Marchand

The Delaware Supreme Court's decision in Marchand does not signal a sea change in Caremark duties. Rather, the decision underscores the duty of oversight identified in Caremark and its progeny, particularly with respect to the obligation for directors to implement monitoring and reporting systems for mission critical issues. As the court reiterated: "Caremark does have a bottom-line requirement that is important: the board must make a good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting." But there is no one right way to implement such systems, as the court emphasized: "As with any other disinterested business judgment, directors have great discretion to design context- and industry-specific approaches tailored to their companies' businesses and resources."

Future cases will define what constitutes a "compliance issue intrinsically critical to the company's business operation," in the court's words, such that directors must establish a board-level monitoring and reporting system to address it. The facts of Marchand suggest that this category of issues may (and should) be relatively narrow: Blue Bell made just one product, and the food-safety issue that arose with respect to that product virtually shut down the company and imperiled its continued existence; the issue truly was mission-critical.

Marchand gives important reminders to directors implementing monitoring and reporting systems. First, directors should be clear-eyed about the key risks facing the company and design board-level monitoring and control systems around those risks. Second, in designing control systems, directors should consider regular reporting by management to the board regarding those specific risks, a board committee with direct oversight of the risks, and adding members to the board (or hiring consultants) with expertise in such critical areas. Third, in light of the important role of Section 220 demands, directors should be sure the board's records show board consideration and deliberation on the identified risks, including specific agenda items, references to deliberations or management reporting in board minutes, material risks disclosed to public investors, and written board materials.